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ch3 - CHAPTER 3 Predetermined Overhead Rates Flexible...

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Chapter 3 CHAPTER 3 Predetermined Overhead Rates, Flexible Budgets, and Absorption/Variable Costing Questions 1. Although both variable and mixed costs change in total with activity measure changes, the difference is that variable costs change in direct proportion to such activity changes and mixed costs do not. Since a mixed cost has both a fixed and variable component, the cost per unit at different activity levels is not constant as it is with a variable cost. 2. No, these are not always the best points of observation. First, the points must be within the relevant range of activity. Second, to be useful, the points must be reflective of the entire data set of observation points. If the high and low points do not meet these two conditions, alternative points should be selected. 3. There are several reasons for using predetermined overhead rates. First, the company does not need to wait to assign overhead costs to products or services until the end of the period when actual costs are known. Second, such rates eliminate overhead cost fluctuations that have nothing to do with volume levels. Third, predetermined overhead rates provide a means to control distortions in product costs caused by changes in volume between or among periods, and the resulting product/service cost changes caused by differences in fixed cost per period. 4. Departmental overhead rates are superior to plant-wide overhead rates in that overhead application bases can be identified that more accurately reflect the causes of costs in each department. In effect, use of departmental rates permit more cost drivers to be identified and used as allocation bases. Separation of variable and fixed costs allows managers to make decisions that rely on knowledge of cost behavior. For example, some decisions require that a manager identify costs that will change if a particular decision alternative (such as whether to manufacture and sell additional units) is implemented. Total variable cost responds differently from total fixed cost to managerial actions. Use of a total overhead rate does not easily allow managers to determine the impact of such differences. 31
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5. The regression method has the major advantage of using all points in the data set to determine the fixed and variable cost elements of the mixed costs. This is in contrast to the high-low method, which uses only two points in the data set. 6. The two differences between absorption and variable costing lie in the treatment of fixed factory overhead and the presentation of costs/expenses on the income statement. Absorption costing treats fixed factory overhead as a product cost and allocates it to the units produced during the period; variable costing treats fixed overhead as a period expense and charges the full amount incurred to the income of the period. Absorption costing presents costs on the income statement in functional categories without regard to cost behavior; variable costing presents costs on the
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